External stability

Question 1

Intro

Answer 1

• Australia’s X stab is historical poor due to low S-I gap and narrow Xport base
• S-I gap: from 1970s to 2000s, australia household savings decreased from 20% to 0% (RBA) due to incrased confidence and falling i/r. Alongside this, 1980s financial deregulation (16 foreign banks entered Aus market) = increased intl. Borrowing = NFD increased from 6% (1980) to 60% of GDP (2016)
• Narrow xport base: 60% of Aus Xports being mining, K-heavy industry, requires high level of K imports, evident with 80% of Aus’ imports by value being manufactured.
• Overall, it pushed CA into 44-year deficit til the surplus in 2019.

Question 2

Measures of ES

Answer 2

• Current Account Deficit (CAD) as a percentage of Gross Domestic Product
• net foreign debt as a percentage of Gross Domestic Product
• net foreign liabilities as a percentage of Gross Domestic Product
• terms of trade
• exchange rate
• international competitiveness

Question 3

P1 (cause - CAD debt accumulation cycle)

Answer 3

• Increased CAD will require increase international borrowing to fund = increawse in NPY debits = increased size of CAD = requires more intl borrowing etc.
• However, in recent years, CAS and NFD has not increased substantially (remained at 60%)

Question 4

P2 (cause: X rate volatility as a cause of poor X stability)

Answer 4

• Poor X stab leads to speculative “attack” on the AUD as
• 95% of currency transactions are speculative
• Evident during COVID with large-scale depreciation from 0.67USD in Feb 2020 to 0.62USD in march 2020.
• Led to speculative decrease in investment inflows, (by 48% in 2020 into aus)
• Overall, poor X stab via exchange rate hinders growth

Question 5

P3 (effect: credit rating)

Answer 5

• X stab deterioration = decrease investor confidence = decreas in credit rating for economy.
• 1. Reduces borrowing capacity because there is less capital inflow funds (and less investment)
• Overall decrease future capacity for growth.
• Stat: during Covid-19 led to the S and P credit rating agency to change their outlook to negative on Australia’s AAA credit rating.
• However, because strong post-covid recovery = budget repair underway and projecting 4.3B surplus 2022-23, reversed mis-outlook.

Question 6

P4 (effect: financial contagion)

Answer 6

• If X stab is poor, Aus becomes more susceptible to financial contagion because of global financial market reliance
• This was evident during covid because FDI inflows halved in 2020 and there was a 13% TOT collapse pushing the economy into -6% GDP grwoth/recession in june 2020
• Therefore more susceptible to financial contagion. (likelihood of happenings in one financial market to affect another financial market/integratino of financial markets/if you have lots of liabilities overseas you’re screwed)

Question 7

P5 (effect: Pitchford thesis)

Answer 7

• Since ~80% of Aus debt is private, and the Consenting Adults Theorem states the private sector will only undertakes borrowing if the profits outweight the costs, there will be a net benefit for the economy.
• Australia has seen 44-year CAD due to high levels of intl borrowing alongside 29 years of recession-free growth. When the recession-free growth trend stopped, it was due to a cyclical, uncontrollable factor (covid).
• This is probably due to increased borrowing having increased expansion of firms -> increased LT e/g.
• [OPTIONAL: expansion of the LNG sector due to increased borrowing. According to Pitchford, LNG profits on BOGS will outweigh repayments on the NPY, which equals overall CA improvement.
• Could be a reason for the CAS since 2019.]

Question 8

P6 (fiscal policy)

Answer 8

• Since increased growth can increase the CAD through increased M expenditure and equity outflows (96% of LNG sector is foreign owned)
• To control size of CAD, govt may engage fiscal consolidation which constrains growth
• Stat: precovid budget moved from 39.6bn deficit (2015-16) to projected 6.2bn surplus (19/20)
• Led to below-par growth of 2.2% in December 2019